Saturday, April 15, 2017

Carlyle's Horbach Shares PEU History

What
is now a $2.5 trillion industry managing money on behalf of public
pensions and the like started as a hodgepodge of so-called leveraged
buyout firms, popularized in the 1980s.

Business
Insider recently sat down with Sandra Horbach, the cohead of US buyouts
at the $158 billion Carlyle Group, to get a sense of how the industry
has changed.

She started with the roots of private equity underwriting (PEU):

When
I started in the business back in 1987, there were two firms with $1
billion in capital: KKR and Forstmann Little & Co.

Bain Capital started in 1984, Oak Hill in 1986 and Carlyle in 1987. The 90's brought Apollo, TPG, Silver Lake and Cerberus.

Thirty years
later, there are thousands of firms with billions in capital. So we've
grown significantly as an industry in a very short period of time.

When I joined Forstmann Little in 1987, right out of business school, it
wasn't even an industry. We didn't call it private equity — it was
leveraged buyouts. It was all about the love of finding great companies
to work with and invest and help build. It wasn't about creating this
mega industry that has since been created.

And that period overlaps with the rapid rise of income for the wealthy and income stagnation or decline for the average citizen. Her love of finding companies to help build doesn't quite fit with

her confession (which goes against the PEU party line).

When
I started in the business, there were a handful of small firms, five,
10 individuals basically looking for great opportunities to invest. Very
little amounts of equity, a lot of leverage. And a lot of returns were
created through financial engineering. The returns that you could
realize back then were significant. You could realize five times, 10
times your money because you were putting smaller amounts of equity into
the entire capital structure.

Horbach confessed her love to "help build" was actually "financial engineering." She knows high leverage places a company at significant risk for default should conditions change. What was not mentioned in the BI interview? The widespread practice of affiliates issuing debt to pay the PEU sponsor a massive dividend.

Horbach shared her "mistake", the implosion of Oriental Trading Company on Carlyle's watch.

Horbach: "... two years into the investment we hit the great recession, and,
simultaneously, the US postal office increased postage rates for
catalogs"

BI: Those two factors seem a bit unpredictable. One the crisis, two the post office.

Horbach: You're right. They were incredibly unpredictable.

Horse hockey to both BI and Horbach. Carlyle's highly leveraged mortgage backed securities vehicle Carlyle Capital Corporation (CCC) entered bankruptcy in spectacular fashion in March 2008, a full six months before Lehman's failure. I believe August 2007 occurred before September 2008.

... an email sent by (Carlyle co-founder William) Conway to CCC chief executive John Stromber on
August 14, 2007—a month after CCC had gone public and as the mortgage
bond market continued to spiral further out of control.

As for Horbach's "unpredictable" assertion Carlyle knew things were going to hell when it asked part owner CalPERS for $681.3 million in capital calls in 2008. Who doesn't love a history rewrite?

Some historians would quibble and say the (LBO-PEU) industry's origins date back much further, though not in any stance like today.

Private equity's tradition of out-sized rewards for the top go far back. The Pharaoh ordered Jewish slaves to make the same number of bricks as before, but they had to gather their own straw. (Exodus 5:7-8)

Idealistic founding father Thomas Jefferson turned PEU in his later years. Smithsonian's article "Master of Monticello" stated this about Jefferson:

It had long been accepted that slaves could be seized for debt, but Jefferson turned this around when he used slaves as collateral for a very large loan
taken out in 1796 from a Dutch banking house in order to rebuild
Monticello. He pioneered the monetizing of slaves, just as he pioneered
the industrialization and diversification of slavery.

Thomas Jefferson levered slaves, which makes him a PEU forefather. Greed is as old as human selfishness and insecurity. Private equity is the master. Returns and image are all that matter.

Insider Architect of the Implosion

"I had a choice. I could be an insider or I could be an outsider. Outsiders can say whatever they want. But people on the inside don’t listen to them. Insiders, however, get lots of access and a chance to push their ideas. People — powerful people — listen to what they have to say. But insiders also understand one unbreakable rule: They don’t criticize other insiders."--Larry Summers, Ph.D.

Testimonials

The PEU Report is absolutely brilliant and has given me faith that someone out there has noticed what is going on in the world. --Ex-Bloomberg reporter

I really can't say enough how much I enjoy your commentary on PEU. You manage to dig into the details and sum it up in a way that is so succinct and entertaining.-Ex-Bloomberg reporter

When Tim Geithner, the former Treasury secretary, takes over as president of Warburg Pincus, the private-equity firm, even a high-school dropout can discern a pattern.-Another person who noticed